A definition that captures much of modern economics is that of
Lionel Robbins in a 1932
essay: "the science which studies human behaviour as a
relationship between ends and scarce means which have alternative
uses." Scarcity means that available
resources are insufficient to
satisfy all wants and needs. Absent scarcity and alternative uses
of available resources, there is no economic problem. The subject thus defined
involves the study of choices
as they are affected by incentives and resources.

Common distinctions are drawn between various dimensions of
economics: between positive
economics (describing "what is") and normative economics (advocating "what
ought to be") or between economic theory and applied economics or between mainstream economics (more "orthodox"
dealing with the "rationality-individualism-equilibrium nexus") and
heterodox economics (more
"radical" dealing with the "institutions-history-social structure
nexus"). However the primary textbook distinction is between
microeconomics ("small" economics),
which examines the economic behavior of agents (including
individuals and firms) and macroeconomics ("big" economics), addressing
issues of unemployment, inflation, monetary and fiscal policy for
an entire economy.

History of economic thought

The city states of Sumer developed a trade and market economy based originally on the commodity money of the Shekel which was a certain weight measure of barley, while the Babylonians and their city state neighbors later
developed the earliest system of economics using a metric of various commodities, that was fixed in a legal code. The
early law codes from Sumer could be considered the first (written)
economic formula, and had many attributes still in use in the
current price system today... such as
codified amounts of money for business deals
(interest rates), fines in money for 'wrong doing', inheritance
rules, laws concerning how private property is to be taxed or
divided, etc. For a summary of the laws, see Babylonian law and Ancient economic thought.

Economic thought dates from earlier Mesopotamian, Greek, Roman,
Indian, Chinese, Persian and Arab
civilizations. Notable writers include Aristotle, Chanakya (also
known as Kautilya), Qin Shi Huang,
Thomas Aquinas and Ibn Khaldun through to the 14th century.
Joseph Schumpeter initially
considered the late
scholastics of the 14th to 17th centuries as "coming nearer
than any other group to being the 'founders' of scientific
economics" as to monetary, interest, and value theory within a
natural-law perspective. After
discovering Ibn Khaldun's Muqaddimah, however, Schumpeter later viewed
Ibn Khaldun as being the closest forerunner of modern economics, as
many of his economic theories were not known in Europe until
relatively modern times.

Nonetheless, recent research indicates that the Indian
scholar-philosopher Chanakya (c. 340-293
BCE) predates Ibn Khaldun by a
millennium and a half as the forerunner of modern economics, and
has written more expansively on this subject, particularly on
political economy. His magnum opus, the Arthashastra (The Science of Wealth
and Welfare), is the genesis of economic concepts that include
the opportunity cost, the demand-supply framework, diminishing
returns, marginal analysis, public goods, the distinction between
the short run and the long run, asymmetric information and the
producer surplus. In his capacity as an advisor to the throne
of the Maurya Empire of ancient
India, he has also advised on the sources and
prerequisites of economic growth, obstacles to it and on tax
incentives to encourage economic growth.

Two other groups, later called 'mercantilists' and 'physiocrats',
more directly influenced the subsequent development of the subject.
Both groups were associated with the rise of economic nationalism and modern
capitalism in Europe. Mercantilism
was an economic doctrine that flourished from the 16th to 18th
century in a prolific pamphlet literature, whether of merchants or
statesmen. It held that a nation's wealth depended on its
accumulation of gold and silver. Nations without access to mines
could obtain gold and silver from trade only by selling goods
abroad and restricting imports other than of gold and silver. The
doctrine called for importing cheap raw materials to be used in
manufacturing goods, which could be exported, and for state
regulation to impose protective tariffs on foreign manufactured
goods and prohibit manufacturing in the colonies.

Physiocrats, a group of 18th century
French thinkers and writers, developed the idea of the economy as a
circular flow of income and output.
Adam Smith described their system "with
all its imperfections" as "perhaps the purest approximation to the
truth that has yet been published" on the subject. Physiocrats
believed that only agricultural production generated a clear
surplus over cost, so that agriculture was the basis of all
wealth.

Thus, they opposed the mercantilist policy of promoting
manufacturing and trade at the expense of agriculture, including
import tariffs. Physiocrats advocated replacing administratively
costly tax collections with a single tax on income of land owners.
Variations on such a land tax were taken up
by subsequent economists (including Henry
George a century later) as a relatively non-distortionary source of tax
revenue. In reaction against copious mercantilist trade
regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal
government intervention in the economy.

Classical political economy

Publication of Adam Smith's The Wealth of Nations in 1776,
has been described as "the effective birth of economics as a
separate discipline." The book identified land, labor, and capital
as the three factors of production and the major contributors to a
nation's wealth.

In Smith's view, the ideal economy is a self-regulating market
system that automatically satisfies the economic needs of the
populace. He described the market mechanism as an "invisible hand"
that leads all individuals, in pursuit of their own self-interests,
to produce the greatest benefit for society as a whole. Smith
incorporated some of the Physiocrats' ideas, including
laissez-faire, into his own economic theories, but rejected the
idea that only agriculture was productive.

While Adam Smith emphasized the production of income, David Ricardo
focused on the distribution of income among landowners, workers,
and capitalists. Ricardo saw an inherent conflict between
landowners on the one hand and labor and capital on the other. He
posited that the growth of population and capital, pressing against
a fixed supply of land, pushes up rents and holds down wages and
profits.

Thomas Robert Malthus used the idea of diminishing returns to
explain low living standards. Population, he argued, tended to
increase geometrically, outstripping the production of food, which
increased arithmetically. The force of a rapidly growing population
against a limited amount of land meant diminishing returns to
labor. The result, he claimed, was chronically low wages, which
prevented the standard of living for most of the population from
rising above the subsistence level.

Malthus also questioned the automatic tendency of a market economy to produce full employment. He
blamed unemployment upon the economy's tendency to limit its
spending by saving too much, a theme that lay forgotten until
John Maynard Keynes revived it
in the 1930s.

Coming at the end of the Classical tradition, John Stuart Mill
parted company with the earlier classical economists on the
inevitability of the distribution of income produced by the market
system. Mill pointed to a distinct difference between the market's
two roles: allocation of resources and distribution of income. The
market might be efficient in allocating resources but not in
distributing income, he wrote, making it necessary for society to
intervene.

Value theory was important in classical theory. Smith wrote that
the "real price of every thing ... is the toil and trouble of
acquiring it" as influenced by its scarcity. Smith maintained that,
with rent and profit, other costs besides wages also enter the
price of a commodity. Other classical economists presented
variations on Smith, termed the 'labour theory of
value'. Classical economics focused on the tendency of markets
to move to long-run equilibrium.

Marxism

Marxist (later, Marxian) economics descends from classical
economics. It derives from the work of Karl
Marx. The first volume of Marx's major work, Das Kapital, was published in German in
1867. In it, Marx focused on the labour theory of value and what he
considered to be the exploitation of labour by capital. The labour
theory of value held that the value of a thing was determined by
the labor that went into its production. This contrasts with the
modern understanding that the value of a thing is determined by
what one is willing to give up to obtain the thing.

Neoclassical economics

A body of theory later termed 'neoclassical economics' or 'marginalism' formed from
about 1870 to 1910. The term 'economics' was popularized by such
neoclassical economists as Alfred
Marshall as a concise synonym for 'economic science' and a
substitute for the earlier, broader term 'political economy'. This corresponded to
the influence on the subject of mathematical methods used in the
natural sciences.

Neoclassical economics systematized supply and demand as joint determinants of
price and quantity in market equilibrium, affecting both the
allocation of output and the distribution of income. It dispensed
with the labour theory of
value inherited from classical economics in favor of a marginal utility theory of value on the
demand side and a more general theory of costs on the supply
side.Campos, Antonietta (1987). "Marginalist Economics", The
New Palgrave: A Dictionary of Economics, v. 3, p. 320

Keynesian economics

Keynesian economics derives from John Maynard Keynes, in particular his
book The General
Theory of Employment, Interest and Money (1936), which
ushered in contemporary macroeconomics as a distinct field. The book
focused on determinants of national income in the short run when
prices are relatively inflexible. Keynes attempted to explain in
broad theoretical detail why high labour-market unemployment might
not be self-correcting due to low "effective demand" and why even price
flexibility and monetary policy might be unavailing. Such terms as
"revolutionary" have been applied to the book in its impact on
economic analysis.

Keynesian economics has two successors. Post-Keynesian economics also
concentrates on macroeconomic rigidities and adjustment processes.
Research on micro foundations for their models is represented as
based on real-life practices rather than simple optimizing models.
It is
generally associated with the University of Cambridge and the work of Joan
Robinson.

New-Keynesian economics is
also associated with developments in the Keynesian fashion. Within
this group researchers tend to share with other economists the
emphasis on models employing micro foundations and optimizing
behavior but with a narrower focus on standard Keynesian themes
such as price and wage rigidity. These are usually made to be
endogenous features of the models, rather than simply assumed as in
older Keynesian-style ones.

Chicago School of economics

The Chicago School of economics is best known for its free market
advocacy and monetarist ideas. According
to Milton Friedman and monetarists,
market economies are inherently stable if
left to themselves and depressions result only from government
intervention. Friedman, for example, argued that the Great
Depression was result of a contraction of the money supply,
controlled by the Federal
Reserve, and not by the lack of investment as Keynes had
argued. Ben Bernanke, current Chairman
of the Federal Reserve, is among the economists today generally
accepting Friedman's analysis of the causes of the Great
Depression.

Milton Friedman effectively took many of the basic principles set
forth by Adam Smith and the classical
economists and modernized them. One example of this is his article
in the September 1970 issue of The New York Times Magazine, where
he claims that the social responsibility of business should be “to
use its resources and engage in activities designed to increase its
profits...(through) open and free competition without deception or
fraud.”

Microeconomics

Microeconomics looks at interactions through individual markets,
given scarcity and government
regulation. A given market might be for a product, say
fresh corn, or the services of a factor of production, say
bricklaying. The theory considers aggregates of quantity demanded by
buyers and quantity supplied by sellers at each possible
price per unit. It weaves these together to describe how the market
may reach equilibrium as to price and quantity or respond to market
changes over time.

This is broadly termed supply and
demand analysis. Market structures, such as perfect competition and monopoly, are examined as to implications for
behavior and economic
efficiency. Analysis of change in a single market often
proceeds from the simplifying assumption that behavioral relations
in other markets remain unchanged, that is, partial-equilibrium analysis. General-equilibrium theory allows for
changes in different markets and aggregates across all
markets, including their movements and interactions toward
equilibrium.

Markets

In microeconomics, production is the
conversion of inputs into outputs. It is an economic process that
uses resources to create a commodity that is suitable for exchange. This can include manufacturing, warehousing, shipping, and
packaging. Some economists define
production broadly as all economic activity other than consumption. They see every
commercial activity other than the final purchase as some form of
production. Production is a process, and as such it occurs through
time and space. Because it is a flow
concept, production is measured as a "rate of output per period
of time".

There are three aspects to production processes, including the
quantity of the commodity produced, the form of the good created
and the temporal and spatial distribution of the commodity
produced. Opportunity cost
expresses the idea that for every choice, the true economic cost is the next best opportunity.
Choices must be made between desirable yet mutually exclusive actions. It has been
described as expressing "the basic relationship between scarcity and choice.". The
notion of opportunity cost plays a crucial part in ensuring that
scarce resources are used efficiently. Thus, opportunity costs are
not restricted to monetary or financial costs: the real cost of output forgone, lost time,
pleasure or any other benefit that provides utility should also be considered.

A variable factor of production is one whose usage rate can be
changed easily. Examples include electrical power consumption,
transportation services, and most raw material inputs. In the
"long-run", all of these factors of
production can be adjusted by management.
In the short run, a firm's "scale of operations" determines the
maximum number of outputs that can be produced, but in the long
run, there are no scale limitations. Long-run and short-run changes
play an important part in economic
models.

Economic efficiency describes
how well a system generates the maximum desired output a with a
given set of inputs and available technology. Efficiency is improved if more output
is generated without changing inputs, or in other words, the amount
of "friction" or "waste" is reduced. Economists look for Pareto efficiency, which is reached when a
change cannot make someone better off without making someone else
worse off.

Economic efficiency is used to refer to a number of related
concepts. A system can be called economically efficient if: No one
can be made better off without making someone else worse off, more
output cannot be obtained without increasing the amount of inputs,
and production ensures the lowest possible per unit cost. These
definitions of efficiency are not exactly equivalent. However, they
are all encompassed by the idea that nothing more can be achieved
given the resources available.

Specialization

Specialization is considered key to economic efficiency because
different individuals or countries have different comparative advantages. While one
country may have an absolute
advantage in every area over other countries, it could
nonetheless specialize in the area which it has a relative
comparative advantage, and thereby gain from trading with countries
which have no absolute advantages. For example, a country may
specialize in the production of high-tech knowledge products, as
developed countries do, and trade with developing nations for goods
produced in factories, where labor is cheap and plentiful.

According to theory, in this way more total products and utility
can be achieved than if countries produced their own high-tech and
low-tech products. The theory of comparative advantage is largely
the basis for the typical economist's belief in the benefits of
free trade. This concept applies to
individuals, farms, manufacturers, service providers, and economies. Among each of these production systems,
there may be a corresponding division of labour with each worker
having a distinct occupation or doing a specialized task as part of
the production effort, or correspondingly different types of
capital equipment and
differentiated land uses.

Adam Smith's Wealth of Nations
(1776) discusses the benefits of the division of labour. Smith
noted that an individual should invest a resource, for example,
land or labour, so as to earn the highest possible return on it.
Consequently, all uses of the resource should yield an equal rate
of return (adjusted for the relative riskiness of each enterprise).
Otherwise reallocation would result. This idea, wrote George Stigler, is the central proposition of
economic theory, and is today called the marginal productivity
theory of income distribution. French economist Turgot had made the same point in 1766.

In more general terms, it is theorized that market incentives,
including prices of outputs and productive
inputs, select the allocation of factors of production by comparative advantage, that is,
so that (relatively) low-cost inputs are employed to keep down the
opportunity
cost of a given type of output. In the process, aggregate
output increases as a by product or
by design. Such specialization of
production creates opportunities for gains from trade whereby resource
owners benefit from trade in the sale of one
type of output for other, more highly-valued goods. A measure of
gains from trade is the increased output (formally, the
sum of increased consumer surplus
and producer profits) from
specialization in production and resulting trade.

Supply and demand

The theory of demand and supply is an organizing principle to
explain prices and quantities of goods sold and changes thereof in
a market economy. In microeconomic theory, it refers to price and
output determination in a perfectly
competitive market. This has served as a building block for
modeling other market structures and for other theoretical
approaches.

For a given market of a commodity, demand shows the
quantity that all prospective buyers would be prepared to purchase
at each unit price of the good. Demand is often represented using a
table or a graph relating price and quantity demanded (see boxed
figure). Demand theory describes
individual consumers as rationally choosing the most
preferred quantity of each good, given income, prices, tastes, etc.
A term for this is 'constrained utility maximization' (with income
as the constraint
on demand). Here, utility refers to the
(hypothesized) preference relation for individual consumers.
Utility and income are then used to model hypothesized properties
about the effect of a price change on the quantity demanded.

The law of demand states that, in
general, price and quantity demanded in a given market are
inversely related. In other words, the higher the price of a
product, the less of it people would be able and willing to buy of
it (other things unchanged). As the
price of a commodity rises, overall purchasing power decreases (the income effect) and consumers move toward
relatively less expensive goods (the substitution effect). Other factors can
also affect demand; for example an increase in income will shift
the demand curve outward relative to the origin, as in the
figure.

Supply is the relation between the price of a good and the quantity
available for sale from suppliers (such as producers) at that
price. Supply is often represented using a table or graph relating
price and quantity supplied. Producers are hypothesized to be
profit-maximizers, meaning that they attempt to produce the amount
of goods that will bring them the highest profit. Supply is
typically represented as a directly proportional relation between
price and quantity supplied (other things unchanged).

In other words, the higher the price at which the good can be sold,
the more of it producers will supply. The higher price makes it
profitable to increase production. At a price below equilibrium,
there is a shortage of quantity supplied compared to quantity
demanded. This pulls the price up. At a price above equilibrium,
there is a surplus of quantity supplied compared to quantity
demanded. This pushes the price down. The model of supply and demand predicts that
for given supply and demand curves, price and quantity will
stabilize at the price that makes quantity supplied equal to
quantity demanded. This is at the intersection of the two curves in
the graph above, market
equilibrium.

For a given quantity of a good, the price point on the demand curve
indicates the value, or marginal
utility to consumers for that unit of output. It measures what
the consumer would be prepared to pay for the corresponding unit of
the good. The price point on the supply curve measures marginal cost, the increase in total cost to
the supplier for the corresponding unit of the good. The price in
equilibrium is determined by supply and demand. In a perfectly competitive market, supply and
demand equate cost and value at equilibrium.

Demand and supply can also be used to model the distribution of income to the
factors of production,
including labour and capital, through factor markets. In a labour
market for example, the quantity of labour employed and the price
of labour (the wage rate) are modeled as set by the
demand for labour (from business firms etc. for production) and
supply of labour (from workers).

Demand and supply are used to explain the behavior of perfectly
competitive markets, but their usefulness as a standard of
performance extends to any type of market. Demand and supply can
also be generalized to explain variables applying to the whole
economy, for example, quantity of total output and the general price level, studied in macroeconomics.

In supply-and-demand analysis, the price of a good coordinates
production and consumption quantities. Price and quantity have been described
as the most directly observable characteristics of a good produced
for the market. Supply, demand, and market equilibrium are
theoretical constructs linking price and quantity. But tracing the
effects of factors predicted to change supply and demand—and
through them, price and quantity—is a standard exercise in applied
microeconomics and macroeconomics. Economic theory can specify
under what circumstances price serves as an efficient communication
device to regulate quantity. A real-world application might attempt
to measure how much variables that increase supply or demand change
price and quantity.

Market failure

The term "market failure" encompasses
several problems which may undermine standard economic assumptions.
Although economists categorise market failures differently, the
following categories emerge in the main texts.

Natural monopoly, or the
overlapping concepts of "practical" and "technical" monopoly,
involves a failure of competition as a restraint on producers. The
problem is described as one where the more of a product is made,
the greater the returns are. This means it only makes economic
sense to have one producer.

Incomplete markets is a term used
for a situation where buyers and sellers do not know enough about
each other's positions to price goods and services properly. Based
on George Akerlof's Market for Lemons article, the paradigm
example is of a dodgy second hand car market. Customers without the
possibility to know for certain whether they are buying a "lemon"
will push the average price down below what a good quality second
hand car would be. In this way, prices may not reflect true
values.

Public goods are goods which are
undersupplied in a typical market. The defining features are that
people can consume public goods without having to pay for them and
that more than one person can consume the good at the same
time.

Externalities occur where there are
significant social costs or benefits from production or consumption
that are not reflected in market prices. For example, air pollution
may generate a negative externality, and education may generate a
positive externality (less crime, etc.). Governments often tax and
otherwise restrict the sale of goods that have negative
externalities and subsidize or otherwise promote the purchase of
goods that have positive externalities in an effort to correct the
price distortions caused by
these externalities. Elementary demand-and-supply theory predicts
equilibrium but not the speed of adjustment for changes of
equilibrium due to a shift in demand or supply.

In many areas, some form of price
stickiness is postulated to account for quantities, rather than
prices, adjusting in the short run to changes on the demand side or
the supply side. This includes standard analysis of the business cycle in macroeconomics. Analysis often revolves
around causes of such price stickiness and their implications for
reaching a hypothesized long-run equilibrium. Examples of such
price stickiness in particular markets include wage rates in labour
markets and posted prices in markets deviating from perfect competition.

Macroeconomic instability, addressed
below, is a prime source of market failure, whereby a general loss
of business confidence or external shock can grind production and
distribution to a halt, undermining ordinary markets that are
otherwise sound.

Firms

One of the assumptions of perfectly competitive markets is that
there are many producers, none of whom can influence prices or act
independently of market forces. In reality, however, people do not
simply trade on markets, they work and produce through firms. The
most obvious kinds of firms are corporations, partnerships and trusts.
According to Ronald Coase people begin
to organise their production in firms when the costs of doing
business becomes lower than doing it on the market. Firms combine
labour and capital, and can achieve far greater economies of scale (when producing two or
more things is cheaper than one thing) than individual market
trading.

Labour economics seeks to understand the functioning of the
market and dynamics for labour. Labour
markets function through the interaction of workers and
employers. Labour economics looks at the suppliers of labour
services (workers), the demanders of labour services (employers),
and attempts to understand the resulting patterns of wages and
other labour income and of employment and unemployment, Practical
uses include assisting the formulation of full employment of policies.

Managerial economics applies microeconomic analysis to specific decisions
in business firms or other management units. It draws heavily from
quantitative methods such as operations research and programming and
from statistical methods such as regression analysis in the absence of
certainty and perfect knowledge. A unifying theme is the attempt to
optimize business
decisions, including unit-cost minimization and profit
maximization, given the firm's objectives and constraints imposed
by technology and market conditions.

Public sector

Public finance is the field of economics that deals with budgeting
the revenues and expenditures of a public
sector entity, usually government. The subject addresses such
matters as tax incidence (who really
pays a particular tax), cost-benefit analysis of government
programs, effects on economic
efficiency and income
distribution of different kinds of spending and taxes, and
fiscal politics. The latter, an aspect of public choice theory, models
public-sector behavior analogously to microeconomics, involving
interactions of self-interested voters, politicians, and
bureaucrats.

Much of economics is positive,
seeking to describe and predict economic phenomena. Normative economics seeks to identify
what is economically good and bad.

Welfare economics is a normative branch of economics that uses
microeconomic techniques to
simultaneously determine the allocative efficiency within an
economy and the income distribution associated with it. It
attempts to measure social welfare by
examining the economic activities of the individuals that comprise
society.

Since at least the 1960s, macroeconomics has been characterized by
further integration as to micro-based modeling of sectors, including
rationality of players,
efficient use of market
information, and imperfect
competition. This has addressed a long-standing concern about
inconsistent developments of the same subject.

Macroeconomic analysis also considers factors affecting the
long-term level and growth of
national income. Such factors include capital accumulation,
technological change
and labor force growth.

Growth

Growth economics studies factors that explain economic growth – the increase in
output per capita of a country over a
long period of time. The same factors are used to explain
differences in the level of output per capita
between countries, in particular why some countries grow
faster than others, and whether countries converge at the same rates of growth.

Over the years, the understanding of the business cycle has branched into various
schools, related to or opposed to Keynesianism. The neoclassical synthesis refers to the
reconciliation of Keynesian economics with neoclassical economics, stating that
Keynesianism is correct in the short run, with the economy
following neoclassical theory in the long run.

In contrast, the New Keynesian
school retains the rational expectations assumption, however it
assumes a variety of market
failures. In particular, New Keynesians assume prices and wages
are "sticky", which means they do
not adjust instantaneously to changes in economic conditions.

Thus, the new classicals assume that prices and wages adjust
automatically to attain full employment, whereas the new Keynesians
see full employment as being automatically achieved only in the
long run, and hence government and central-bank policies are needed
because the "long run" may be very long.

Inflation and monetary policy

Money is a means of final payment for
goods in most price system economies
and the unit of account in which
prices are typically stated. It includes currency held by the
nonbank public and checkable deposits. It has been described as a
social convention, like language, useful to one largely because it
is useful to others.

As a medium of exchange, money
facilitates trade. Its economic function can be contrasted with
barter (non-monetary exchange). Given a
diverse array of produced goods and specialized producers, barter
may entail a hard-to-locate double coincidence of wants as
to what is exchanged, say apples and a book. Money can reduce the
transaction cost of exchange
because of its ready acceptability. Then it is less costly for the
seller to accept money in exchange, rather than what the buyer
produces.

Fiscal policy and regulation

National accounting is a method for summarizing aggregate economic
activity of a nation. The national accounts are double-entry accounting systems that
provide detailed underlying measures of such information. These
include the national income and product
accounts (NIPA), which provide estimates for the money value of
output and income per year or quarter.

International economics

International trade studies determinants of goods-and-services
flows across international boundaries. It also concerns the size
and distribution of gains from
trade. Policy applications include estimating the effects of
changing tariff rates and trade quotas.
International finance is a
macroeconomic field which examines the flow of capital across international borders,
and the effects of these movements on exchange rates. Increased trade in goods,
services and capital between countries is a major effect of
contemporary globalization.

Economic systems is the branch
of economics that studies the methods and institutions by which societies determine the
ownership, direction, and allocaton of economic resources. An
economic system of a society is the unit of
analysis.

Heterodox economists place less emphasis upon mathematics, and
several important historical economists, including Adam Smith and
Joseph Schumpeter, have not been
mathematicians. Economic reasoning involves intuition regarding
economic concepts, and economists attempt to analyze to the point
of discovering unintended
consequences.

Theory

Mainstream economic theory relies upon a
priori quantitative economic
models, which employ a variety of concepts. Theory typically
proceeds with an assumption of ceteris paribus, which means holding
constant explanatory variables other than the one under
consideration. When creating theories, the objective is to find
ones which are at least as simple in information requirements, more
precise in predictions, and more fruitful in generating additional
research than prior theories.

Expositions of economic reasoning often use two-dimensional graphs
to illustrate theoretical relationships. At a higher level of
generality, Paul Samuelson's treatise
Foundations of
Economic Analysis (1947) used mathematical methods to
represent the theory, particularly as to maximizing behavioral
relations of agents reaching equilibrium. The book focused on
examining the class of statements called operationally
meaningful theorems in economics, which are theorems that can conceivably be refuted by
empirical data.

Empirical investigation

Economic theories are frequently tested empirically, largely through the use of econometrics using economic data. The controlled experiments
common to the physical sciences are
difficult and uncommon in economics , and instead broad data is
observationally studied; this
type of testing is typically regarded as less rigorous than
controlled experimentation, and the conclusions typically more
tentative. The number of laws discovered by the discipline of
economics is relatively very low compared to the physical
sciences.

Statistical methods such as regression analysis are common.
Practitioners use such methods to estimate the size, economic
significance, and statistical
significance ("signal strength") of the hypothesized
relation(s) and to adjust for noise from other variables. By such
means, a hypothesis may gain acceptance, although in a
probabilistic, rather than certain, sense. Acceptance is dependent
upon the falsifiable hypothesis
surviving tests. Use of commonly accepted methods need not produce
a final conclusion or even a consensus on a particular question,
given different tests, data sets, and prior
beliefs.

Criticism based on professional standards and non-replicability of results serve as
further checks against bias, errors, and over-generalization,
although much economic research has been accused of being
non-replicable, and prestigious journals have been accused of not
facilitating replication through the provision of the code and
data. Like theories, uses of test statistics are themselves open to
critical analysis, although critical commentary on papers in
economics in prestigious journals such as the American Economic Review has
declined precipitously in the past 40 years. This has been
attributed to journals' incentives to maximize citations in order
to rank higher on the Social Science Citation Index (SSCI).

In applied economics, input-output
models employing linear
programming methods are quite common. Large amounts of data are
run through computer programs to analyze the impact of certain
policies; IMPLAN is one
well-known example.

In behavioral economics,
psychologists Daniel Kahneman and
Amos Tversky have won Nobel Prizes in
economics for their empirical discovery of several cognitive biases and heuristics. Similar empirical testing occurs in
neuroeconomics. Another example is
the assumption of narrowly selfish preferences versus a model that
tests for selfish, altruistic, and cooperative preferences. These
techniques have led some to argue that economics is a "genuine
science.".

Game theory

Game theory is a branch of applied
mathematics that studies strategic interactions between agents.
In strategic games, agents choose strategies that will
maximize their payoff, given the strategies the other agents
choose. It provides a formal modeling approach to social situations
in which decision makers interact with other agents.

Profession

The professionalization of economics, reflected in the growth of
graduate programs on the subject, has been described as "the main
change in economics since around 1900". Most major universities and many colleges have a major,
school, or department in which academic
degrees are awarded in the subject, whether in the liberal arts, business, or for professional
study.

Law and economics, or economic analysis of law, is an approach to
legal theory that applies methods of economics to law. It includes
the use of economic concepts to explain the effects of legal rules,
to assess which legal rules are economically efficient, and to predict
what the legal rules will be. A seminal article by Ronald Coase published in 1961 suggested that
well-defined property rights could overcome the problems of
externalities.

Political economy is the
interdisciplinary study that combines economics, law, and political science in explaining how
political institutions, the political environment, and the economic
system (capitalist, socialist, mixed) influence each other. It studies
questions such as how monopoly, rent seeking behavior, and externalities should impact government policy.
Historians have employed political
economy to explore the ways in the past that persons and
groups with common economic interests have used politics to effect
changes beneficial to their interests.

Criticisms of economics

"The dismal science" is a
derogatory alternative name for economics devised by the Victorian historian Thomas Carlyle in the 19th century. It is
often stated that Carlyle gave economics the nickname "the dismal
science" as a response to the late 18th century writings of The
Reverend Thomas Robert Malthus, who
grimly predicted that starvation would result, as projected
population growth exceeded the rate of increase in the food supply.
The teachings of Malthus eventually became known under the umbrella
phrase "Malthus' Dismal
Theorem". His predictions were forestalled by unanticipated
dramatic improvements in the efficiency of food production in the 20th century; yet the
bleak end he proposed remains as a disputed future possibility,
assuming human innovation fails to keep up with population
growth.

Some economists, like John Stuart
Mill or Leon Walras, have maintained
that the production of wealth should not be tied to its
distribution. The former is in the field of "applied economics"
while the latter belongs to "social economics" and is largely a
matter of power and politics.

In The Wealth of Nations, Adam
Smith addressed many issues that are currently also the subject
of debate and dispute. Smith repeatedly attacks groups of
politically aligned individuals who attempt to use their collective
influence to manipulate a government into doing their bidding. In
Smith's day, these were referred to as factions, but are now more commonly called
special interests, a term which
can comprise international bankers, corporate conglomerations,
outright oligopolies, monopolies, trade
unions and other groups.

Economics per se, as a social science, is independent of the
political acts of any government or other decision-making
organization, however, many policymakers
or individuals holding highly ranked positions that can influence
other people's lives are known for arbitrarily using a plethora of
economic concepts and rhetoric as vehicles
to legitimize agendas and value systems, and do not limit their remarks
to matters relevant to their responsibilities. The close relation
of economic theory and practice with politics is a focus of contention that may shade or
distort the most unpretentious original tenets of economics, and is
often confused with specific social agendas and value
systems.

In Steady State Economics 1977, Herman Daly argues that there exist logical
inconsistencies between the emphasis placed on economic growth and
the limited availability of natural resources.

Deirdre McCloskey has argued that
many empirical economic studies are poorly reported, and while
her critique has been
well-received, she and Stephen Ziliak argue that practice has not
improved. This latter contention is controversial.

A 2002
International
Monetary Fund study looked at “consensus forecasts” (the
forecasts of large groups of economists) that were made in advance
of 60 different national recessions in the ’90s: in 97% of the
cases the economists did not predict the contraction a year in
advance. On those rare occasions when economists did
successfully predict recessions, they significantly underestimated
their severity..

Criticism of assumptions

Economics has been subject to criticism that it relies on
unrealistic, unverifiable, or highly simplified assumptions, in
some cases because these assumptions lend themselves to elegant
mathematics. Examples include perfect information, profit maximization and rational choices.

Some contemporary economic theory has focused on addressing these problems through the emerging subdisciplines of information economics, behavioral economics, and complexity economics, with Geoffrey Hodgson forecasting a major shift in the mainstream approach to economics. Nevertheless, prominent mainstream economists such as Keynes and Joskow, along with heterodox economists, have observed that much of economics is conceptual rather than quantitative, and difficult to model and formalize quantitatively. In a discussion on oligopoly research, Paul Joskow pointed out in 1975 that in practice, serious students of actual economies tended to use "informal models" based upon qualitative factors specific to particular industries. Joskow had a strong feeling that the important work in oligopoly was done through informal observations while formal models were "trotted out ex post". He argued that formal models were largely not important in the empirical work, either, and that the fundamental factor behind the theory of the firm, behavior, was neglected.

Despite these concerns, mainstream graduate programs have become
increasingly technical and mathematical. Although much of the most
groundbreaking economic research in history involved concepts
rather than math, today it is nearly impossible to publish a
non-mathematical paper in top economic journals. Disillusionment on
the part of some students with the abstract and technical focus of
economics led to the post-autistic economics movement,
which began in France in 2000.

David Colander, an advocate of
complexity economics, has also
commented critically on the mathematical methods of economics,
which he associates with the MIT approach to economics, as opposed
to the Chicago approach (although he also states that the Chicago
school can no longer be called intuitive). He believes that the
policy recommendations following from Chicago's intuitive approach
had something to do with the decline of intuitive economics. He
notes that he has encountered colleagues who have outright refused
to discuss interesting economics without a formal model, and he
believes that the models can sometimes restrict intuition. More
recently, however, he has written that heterodox economics, which generally
takes a more intuitive approach, needs to ally with mathematicians
and become more mathematical. "Mainstream economics is a formal
modeling field", he writes, and what is needed is not less math but
higher levels of math. He notes that some of the topics highlighted
by heterodox economists, such as the importance of institutions or
uncertainty, are now being studied in the mainstream through
mathematical models without mention of the work done by the
heterodox economists. New
institutional economics, for example, examines institutions
mathematically without much relation to the largely heterodox field
of institutional
economics.

In his 1974 Nobel Prize
lecture, Friedrich Hayek, known for
his close association to the heterodox school of Austrian economics, attributed policy
failures in economic advising to an uncritical and unscientific
propensity to imitate mathematical procedures used in the physical
sciences. He argued that even much-studied economic phenomena, such
as labor-market unemployment, are
inherently more complex than their counterparts in the physical
sciences where such methods were earlier formed. Similarly, theory
and data are often very imprecise and lend themselves only to the
direction of a change needed, not its size. In
part because of criticism, economics has undergone a thorough
cumulative formalization and elaboration of concepts and methods
since the 1940s, some of which have been toward application of the
hypothetico-deductive
method to explain real-world phenomena.

Nordhaus, William D. (2002). "The
Economic Consequences of a War with Iraq", in War with Iraq:
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Davis, John B. (2006). "Heterodox Economics, the Fragmentation
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Directions in Heterodox Economics. Ann Arbor: University of
Michigan Press.

Anne O. Krueger, "The Political Economy of the Rent-Seeking
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